July 14, 2023
By Steve Blumenthal
“The stock market is never obvious. It is designed to fool most of the people, most of the time.”
“I believe the only edge in investing is innovation.”
– Mark Finn, Chairman, CEO, and COO, Vantage Consulting Group
One of my favorite bond market indicators is the Zweig Bond Model, created by Martin Zweig. Years ago, I saw a post from Ned Davis, co-founder of Ned Davis Research, highlighting the model. I had read Marty’s book, Winning on Wall Street, and had been a subscriber to his research service in the 1990s.
If my memory serves me correctly, Ned and Marty were good friends and worked together to recreate the model, including a fifth rule suggested by Ned. At the time I saw Davis’s post, the Zweig Bond Model was not discussed regularly, so I asked the NDR research team to do some custom work for me and recreate the model so that it automatically updated for me each week. NDR has been posting the chart to my private research page for more years than I can remember, and monitoring it frequently has served me well. It remains my go-to technical indicator for assessing the direction of interest rates. I caution, like all things in this business, no guarantees can be made.
It is certainly on my radar this week since it just reached a reading not seen since the early 1980s. The chart follows below.
In his book, Zweig says, “People somehow think you must buy at the bottom and sell at the top to be successful in the market. That’s nonsense. The idea is to buy when the probability is greatest that the market is going to advance.” He used fundamental company data to select stocks to buy and technical data to identify when the market was positive.
The inspiration behind a number of Zweig’s methods came, he said, from Jesse Livermore, who was considered one of the greatest speculators that ever lived. He was the subject of a book titled Reminiscences of a Stock Operator, which remains one of the most widely read and highly recommended investment books ever written. In fact, it was the first book my good friend John Ray handed to me in 1984 (“I want it back,” he added.), and to this day, it is the best book on markets and human investment behavior I have ever read. I definitely recommend getting a copy for yourself.
Why is this important now, though? We are in a different environment than in the last 35+ years. Over the past several decades, we witnessed incredible globalization, booming offshore manufacturing, increased low-cost labor, just-in-time inventory, the end of the Cold War, persistently low inflation, and a long-term cycle trend of declining interest rates. That is not the world we’re in today. The years ahead, in my view, will favor active management and stock selection, where we will need to think more like Jesse Livermore and Marty Zweig and less like the late, great John Bogle.
The Cost of Money
Everything pivots on the cost of money. When the cost of capital was zero percent, the upside for stock returns was technically unlimited. Companies could borrow at very low-interest rates, and they could use that money—and many did—to buy back shares of their own stock. Individual and institutional investors seeking better returns than low-yielding bonds, zero-interest-rate money market accounts, and low-yielding CDs shifted their money into equities. “There is no alternative”—or TINA—was their argument. But the winds have shifted.
Higher inflation and higher interest rates mean higher input costs. The cost of money is higher, and it will likely impact company earnings (lower). We are now in the early innings of this new game.
Is a 5% yielding short-term Treasury attractive enough? Probably.
Is a 3.86% yielding 10-year Treasury attractive enough? Not if inflation and wage pressures persist and unemployment remains low.
In that case, the Fed will stay its course. If rates rise another 100 bps from here, that 10-year Treasury Note will decline in value by approximately another 10% and the 30-year Treasury Bond by more than 25%.
That’s a very real possibility.
This brings us back to the importance of the trend in interest rates. Higher interest rates are bad for bond investors and stock investors as well.
But let me digress with a quick side story… At the beginning of 2019, I held a fundamental view that interest rates would rise from 3% to approximately 3.5%. Many others in our industry agreed with me. One of the major publications—I believe it was Barron’s—conducted a survey asking 23 Wall Street analysts for their prediction on interest rates for the year. All 23 believed interest rates would rise, with targets ranging from 3.25% to 4%. Nevertheless, the 10-year yield declined to approximately 2.5%. The Zweig Bond Model remained in a buy signal for almost the entirety of the year. All 23 analysts and I were wrong.
No process is perfect—whether it’s based on one’s fundamental view or the rules of a technical model. If the technical predictions don’t support your fundamental view, be careful. Now, I’m looking for the 10-year to move back above 4% and the Zweig Bond Model to move back to a “buy” signal. If I’m right about the coming recession and slowing inflation, interest rates should fall. I’m looking for Zweig Bond Model technical indicator to support this fundamental view.
Next is the chart with data going back to 1967. Note this is a hypothetical performance and does not represent real-life performance returns.
(See: Trade Signals Subscription Acknowledgement and Important Disclosures)
Here’s how to read the chart:
- Rules are in the upper left of the chart.
- The signal is in the middle of the chart. The score ranges from +5 to -5. Each rule gets a score (+1 or -1).
- The yellow highlight in the lower section bottom right shows the current signal.
Grab that coffee, find your favorite chair, and read on.
You’ll find an interesting discussion about investor sentiment – the Put/Call Ratio. And a link to my recent podcast discussion on valuations and a few excellent Random Tweets.
Here are the sections in this week’s On My Radar:
- The Put/Call Ratio
- OMR Valuation Podcast Discussion
- Random Tweets
- Trade Signals: Inflation 3%, the Zweig Bond Model at –5 (a reading not seen since the 1980s), Oil Back Above $80, and the Equity Market Trend Remains Bullish
- Personal Note: Stonewall
(Reminder: This is not a recommendation to buy or sell any security. My views may change at any time. The information is for discussion purposes only.)
If you are not signed up to receive the free weekly On My Radar letter, subscribe here.
The Put/Call Ratio
The Put/Call Ratio is a market indicator that compares the trading volume of put options to that of call options within a given time frame. It’s calculated by dividing the total number of traded put contracts by the total number of traded call contracts.
- Put options are financial instruments that give the holder the right, but not the obligation, to sell an underlying asset at a specified price (strike price) within a predetermined period. Put options are often associated with bearish investor sentiment—aka betting the stock market will go down.
- Call options, on the other hand, are financial instruments that give the holder the right, but not the obligation, to buy an underlying asset at a specified price (strike price) within a predetermined period. Call options are generally linked to bullish sentiment—aka betting the stock market will go up.
By analyzing the Put/Call Ratio, investors and traders aim to gain insights into investors’ current mindset. A high Put/Call Ratio indicates that there is more trading volume in put options (traders betting the market will go down) compared to call options (traders betting the market will go up). This could suggest a higher level of bearish sentiment, which, at extremes, is a very bullish indicator.
Legendary investor Warren Buffett is known for advising investors to be fearful when others are greedy and greedy when others are fearful, which is in line with today’s Put/Call Ratio sentiment: When the stock market is at extremes, go against the crowd. By doing so, investors may benefit from contrarian opportunities and avoid the pitfalls of herd mentality.
Essentially, the Put/Call Ratio is used as a contrarian indicator, meaning that extreme readings (either very high or very low) may signal a potential reversal in the market’s direction. It should not, however, be used in isolation but rather as part of a broader analysis that considers several indicators and factors impacting the market.
So, where are we today?
According to an email I received this week from Tom McClellan:
“Persistently low readings lately for the CBOE Put/Call Volume Ratio (for all products) have pulled down the 5-day moving average to its lowest reading since the top of the last bull market in December 2021. Such readings are pretty reliably associated with meaningful tops for stock prices. That is, unless the Fed has its thumb on the scale.”
Tom described how, in response to onset of Covid-19 and the lockdowns in March 2020, the Fed initiated its fourth round of quantitative easing (QE), at one point putting an influx of nearly $1 trillion into the banking system. Because the economy couldn’t account for so much money, stock prices were pushed up and readings for the 5-day MA of the Put/Call Ratio were much lower. Tom went on:
“Now we have a really low reading but no QE. In fact, the Fed is still trying to dismantle the stimulus it did with QE4 by reducing their holdings of the Treasury and mortgage debt that the Fed bought up back in 2020-21. So, we do not have that same condition now to mess with what should be a perfectly good indication of trader overconfidence.”
He concluded, “But readings like we are seeing this week in the Put/Call Ratio’s 5-day MA do tend to matter, eventually, as long as the Fed does not get in the way.”
Here’s a look at the chart Tom posted:
- Focus on the red line in the lower half of the chart
- Middling values really do not tell us much. It is only when the Put/Call Ratio gets to an extreme that it becomes useful.
- Above the upper dotted line signals an extreme of high put option volume vs. call option volume (a market extreme buy signal)
Below the dotted line signals an extreme of high call option volume vs. put option volume (a market extreme sell signal)
Here’s a note from Tom on the chart: “The upper and lower threshold lines in the chart above are arbitrarily drawn, and one could reasonably argue that either of them ought to be moved up or down a little bit. It is also worth noting that the reaching of an extreme level for this (or any) indicator is not a ‘signal’, but rather it represents a ‘condition.’ The market does not necessarily have to react immediately just because you or I may notice an extended condition.”
To identify points of extreme, we are looking for what to see what values have mattered in the past.
Below, I’ve shared another chart, which I included in yesterday’s edition of Trade Signals.
Here’s how to read it:
- The Red Zone shows readings below 0.80 and indicates “Extreme Optimism” which marks a probable bearish turning point for stocks
- The red arrow indicates the level on July 11, and the orange circle top right of the chart is the same level
- The Green Zone shows readings above 1.20 and indicates “Extreme Pessimism,” which marks a potential bullish turning point for stocks.
Tom McClellan is the Editor of The McClellan Market Report. You can sign up to receive his updated emails for free. He is also famous for creating the McClellan Oscillator, a valuable tool for market participants. If you are curious, you can learn more here.
If you are not signed up to receive the free weekly On My Radar letter, subscribe here.
On My Radar: 2023 Mid-Year Market Valuation Podcast
CMG’s Brian Schreiner asked me to walk through the most recent OMR valuation report. Hope you enjoy the discussion. Click on the photo to listen to the Podcast (21 mins).
(Reminder: This is not a recommendation to buy or sell any security. My views may change at any time. The information is for discussion purposes only.)
If you are not signed up to receive the free weekly On My Radar letter, you can subscribe here.
Random Tweets
With the debt ceiling temporarily uncapped until after the November 2024 Presidential election, it is likely the Treasury will issue more debt, and the Fed will print the money to finance that debt. A recession would make things far more difficult for the incumbent party. The fiscal authorities’ foot remains on the gas.
Get ready to roll your eyes… this is from Charlie Bilello:
The Covid cash is expected to be gone by the end of this year, according to this week from Schwab’s Liz Ann Sonders:
Global Central Bank balance sheets in dollars (unwinding continues):
Here is a blown-up version of that same chart:
Chairman Powell’s preferred U.S. yield curve indicator is the 10-year vs 3-month yield spread:
Just another warning we’ll someday look back on nodding yes:
Finally, as I sat in my chair this morning with Susan and coffee in hand, she started laughing and immediately sent me a picture of this next tweet.
(Reminder: This is not a recommendation to buy or sell any security. My views may change at any time. The information is for discussion purposes only.)
If you are not signed up to receive the free weekly On My Radar letter, you can subscribe here.
Trade Signals: Inflation 3%, the Zweig Bond Model at –5 (a reading not seen since the 1980s), Oil Back Above $80, and the Equity Market Trend Remains Bullish
“Extreme patience combined with extreme decisiveness. You may call that our investment process. Yes, it’s that simple.”
– Charlie Munger
Subscribers can find the chart by clicking the log-in button below. If you are not a subscriber and would like a sample, reply to this email “send me a sample Trade Signals letter.”
Click on the “Subscribe to Trade Signals” picture to log in or sign up.
TRADE SIGNALS SUBSCRIPTION ACKNOWLEDGEMENT / IMPORTANT DISCLOSURES
About Trade Signals
Trade Signals provides a weekly snapshot of current stock, bond, currency, and gold market trends. We provide a summary of technical indicators to help you identify where we sit in short, intermediate, and long-term cycles. We track important valuation metrics to determine the probability of future returns (i.e. when return opportunity is best/least). Trade Signals also tracks investor sentiment indicators and economic and select recession watch indicators. Trade Signals is now a low-cost subscription service, about the cost of two Starbucks lattes every month. You can find the archive of weekly Trade Signals posts (2008 through 2-15-23) by clicking here.
100% Spam-free. No list sharing. No solicitations. Opt out anytime with one click.
TRADE SIGNALS SUBSCRIPTION ACKNOWLEDGEMENT / IMPORTANT DISCLOSURES
Not a recommendation for you to buy or sell any security. For information purposes only. Please discuss needs, goals, time horizons, and risk tolerances with your advisor. Investing involves risk. You can lose some or all of your money.
If you are not signed up to receive the free weekly On My Radar letter, you can sign up here.
Personal Note: Stonewall
Mark Finn has been a friend and mentor of mine for the last 20 years, and I continue to learn from him to this day. I’m greatly looking forward to a visit from him next Tuesday. We’re going to play golf at Stonewall. As you probably know by now, I’m in love with Stonewall.
Stonewall North Course – Hole 11 with Cottage behind the 12’th tee
After our day of golfing, Mark and I will have a laid-back dinner with several other friends and industry experts, including asset managers, a hedge fund manager, a former head of Citi’s fixed income division, several clients, and team members. One of our former employees and good friend, Jason Wilder, founded a smoked-meat business. My Texas friends say Jason’s bbq is as good as anything they find in Texas. He’ll be bringing his truck and smoker and cooking for 20 of us—brisket, pulled pork, chicken, and salmon. I’m hungry already. Drinks and dinner will start around 6:30 pm, and we’ll watch the sunset over the course. I’m really looking forward to the conversations and time together.
Checking in happy with much anticipation for next week. And grateful, of course. I just need Finn to fix my short wedge game…
I hope this note finds you with fun plans in your immediate future as well.
Wishing you a wonderful week!
Steve
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
Private Wealth Client Website – www.cmgprivatewealth.com
TAMP Advisor Client Webiste – www.cmgwealth.com
If you are not signed up to receive the free weekly On My Radar letter, you can sign up here. Follow me on Spotify, Twitter @SBlumenthalCMG, and LinkedIn.
Forbes Book – On My Radar, Navigating Stock Market Cycles. Stephen Blumenthal gives investors a game plan and the advice they need to develop a risk-minded and opportunity-based investment approach. It is about how to grow and defend your wealth. You can learn more here.
Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Executive Chairman and CIO. Steve authors a free weekly e-letter entitled, “On My Radar.” Steve shares his views on macroeconomic research, valuations, portfolio construction, asset allocation and risk management.
Follow Steve on Twitter @SBlumenthalCMG and LinkedIn.
IMPORTANT DISCLOSURE INFORMATION
This document is prepared by CMG Capital Management Group, Inc. (“CMG”) and is circulated for informational and educational purposes only. There is no consideration given to the specific investment needs, objectives, or tolerances of any of the recipients. Additionally, CMG’s actual investment positions may, and often will, vary from its conclusions discussed herein based on any number of factors, such as client investment restrictions, portfolio rebalancing, and transaction costs, among others. Recipients should consult their own advisors, including tax advisors, before making any investment decision. This material is for informational and educational purposes only and is not an offer to sell or the solicitation of an offer to buy the securities or other instruments mentioned. This material does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual investors which are necessary considerations before making any investment decision. Investors should consider whether any advice or recommendation in this research is suitable for their particular circumstances and, where appropriate, seek professional advice, including legal, tax, accounting, investment, or other advice.
Investing involves risk. Past performance does not guarantee or indicate future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by CMG), or any non-investment related content, made reference to directly or indirectly in this commentary will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this commentary serves as the receipt of, or as a substitute for, personalized investment advice from CMG. Please remember to contact CMG, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. Unless, and until, you notify us, in writing, to the contrary, we shall continue to provide services as we do currently. CMG is neither a law firm, nor a certified public accounting firm, and no portion of the commentary content should be construed as legal or accounting advice.
No portion of the content should be construed as an offer or solicitation for the purchase or sale of any security. References to specific securities, investment programs or funds are for illustrative purposes only and are not intended to be, and should not be interpreted as recommendations to purchase or sell such securities.
This presentation does not discuss, directly or indirectly, the amount of the profits or losses realized or unrealized, by any CMG client from any specific funds or securities. Please note: In the event that CMG references performance results for an actual CMG portfolio, the results are reported net of advisory fees and inclusive of dividends. The performance referenced is that as determined and/or provided directly by the referenced funds and/or publishers, has not been independently verified, and does not reflect the performance of any specific CMG client. CMG clients may have experienced materially different performance based upon various factors during the corresponding time periods. See in links provided citing limitations of hypothetical back-tested information. Past performance cannot predict or guarantee future performance. Not a recommendation to buy or sell. Please talk to your advisor.
Information herein has been obtained from sources believed to be reliable, but we do not warrant its accuracy. This document is general communication and is provided for informational and/or educational purposes only. None of the content should be viewed as a suggestion that you take or refrain from taking any action nor as a recommendation for any specific investment product, strategy, or other such purposes.
In a rising interest rate environment, the value of fixed-income securities generally declines, and conversely, in a falling interest rate environment, the value of fixed-income securities generally increases. High-yield securities may be subject to heightened market, interest rate, or credit risk and should not be purchased solely because of the stated yield. Ratings are measured on a scale that ranges from AAA or Aaa (highest) to D or C (lowest). Investment-grade investments are those rated from highest down to BBB- or Baa3.
NOT FDIC INSURED. MAY LOSE VALUE. NO BANK GUARANTEE.
Certain information contained herein has been obtained from third-party sources believed to be reliable, but we cannot guarantee its accuracy or completeness.
In the event that there has been a change in an individual’s investment objective or financial situation, he/she is encouraged to consult with his/her investment professional.
Written Disclosure Statement. CMG is an SEC-registered investment adviser located in Malvern, Pennsylvania. Stephen B. Blumenthal is CMG’s founder and CEO. Please note: The above views are those of CMG and its CEO, Stephen Blumenthal, and do not reflect those of any sub-advisor that CMG may engage to manage any CMG strategy, or exclusively determines any internal strategy employed by CMG. A copy of CMG’s current written disclosure statement discussing advisory services and fees is available upon request or via CMG’s internet web site at www.cmgwealth.com/disclosures. CMG is committed to protecting your personal information. Click here to review CMG’s privacy policies.